Since the resumption of the issuance of treasury bonds in 1981, the mainland treasury bond market has undergone a series of reforms and developments and has made remarkable achievements. As an infrastructure for resource allocation, a platform for macroeconomic policy regulation and control, and an important investment place for investors at home and abroad, the treasury bond market has played an important role in the development and reform of the national economy. Liquidity is the key attribute of the market, and the continuous improvement of the liquidity of the mainland treasury bond market in recent years has effectively promoted the function of the treasury bond market. Looking forward to the future, the new development stage has put forward higher requirements for the improvement of the modern fiscal and taxation system, and further improving the liquidity of the treasury bond market is of great significance and role in improving the modern fiscal and taxation system.
First, the liquidity of the mainland treasury bond market has been continuously improved
(1) Measurement of liquidity
The definition of the liquidity concept of the treasury bond market by domestic and foreign scholars is mainly from the three dimensions of price, quantity and time. According to the Definition of the Liquidity Concept of the Treasury Bond Market by the Bank for International Settlements, liquidity refers to the fact that all kinds of different entities participating in market transactions can quickly achieve transactions of a certain scale without producing a large and significant change in the price level.
Regarding the measurement of market liquidity, Kyle (1985) first proposed the three aspects of "width", "depth" and "elasticity", and then Harris (1990) added "immediacy" to this basis, forming a four-dimensional measurement framework, and most scholars have carried out research under this framework since then. Width is the magnitude of the deviation between the buyer's or seller's transaction price and the market equilibrium price. Depth refers to the volume of trades that do not affect the market price, or the quantity of bonds bought and sold at a specific price. Immediacy refers to the time it takes for a trader to complete a certain volume of transactions at a given cost. Elasticity refers to the degree of impact on the price given the trading time window and the size of the trade.
(2) Basic situation of liquidity
Combined with the actual situation of the mainland bond market and the availability of data, from the indicators of annual turnover and annual turnover rate, since 2008, with the continuous expansion of the treasury bond market, the continuous improvement of relevant market mechanisms such as primary issuance and secondary trading in the treasury bond market, the liquidity of the treasury bond market has increased significantly, and the annual turnover has increased from 3.66 trillion yuan in 2008 to 46.47 trillion yuan in 2020, with an annual compound growth rate of 23.58% The annual turnover rate increased from 0.69 in 2008 to 2.25 in 2020, with a compound annual growth rate of 10.31%.
Figure 1: Turnover and turnover rate of the mainland treasury bond market
Note: Annual turnover rate = Treasury bond turnover / Balance of Treasury Bonds at the end of the year
Compared with the international market, the annual turnover rate of the mainland treasury bond market as of 2020 has exceeded the level of Japan, South Korea and Singapore, and the gap with the US market has narrowed. From the perspective of the past six years, the turnover rate of the mainland treasury bond market has increased by about 1 times, while the treasury bond market turnover rate of the United States, Japan and South Korea has dropped by about 16%, 26% and 37% respectively. If you push the time forward to 2008, it can be found that the liquidity indicators of the US Treasury bond market in 2020 fell to about 41% in 2008, the liquidity weakened significantly, and the liquidity of the US Treasury bond market showed the opposite trend. The weakening liquidity of US Treasury bonds may be related to the negative effects of unconventional monetary policies such as quantitative easing; in contrast, the mainland's normal monetary policy provides favorable conditions for enhancing the function of mainland treasury bonds as an international safe asset and promoting the internationalization of the renminbi.
Figure 2: Treasury bond market turnover rates in China, the United States, and major East Asian countries
Data quoted from: Zhou Zhou and Li Hongxi, "Series of Research on Treasury Bond Yields: Research on The Factors Influencing liquidity of the Mainland Treasury Bond Market"
Figure 3: Comparison of the trend of change rates of Chinese and US Treasury bonds
Note: Annual turnover rate of U.S. Treasury bonds = Average daily trading volume of U.S. Treasury bonds * 360 / Total U.S. Treasury bonds outstanding
Looking at the process of continuous improvement of the liquidity of the mainland treasury bond market in the midst of fluctuations, it can be seen that the liquidity of treasury bonds is inseparable from the three factors of mechanism construction, investor structure and market conditions.
In terms of mechanism construction, with the deepening of the reform of the government bond issuance management system in recent years, the standardized and transparent government debt financing mechanism has become increasingly sound, and the introduction of a series of market mechanisms has played an important role in improving the liquidity of the government bond market. In terms of the structure of the bonds, the key maturity of treasury bonds has been further improved, the rolling issuance mechanism of short-term treasury bonds has been gradually established and improved, and the frequency and scale of medium- and long-term treasury bonds have been increased, which has effectively increased the tradable scale of single treasury bonds, reduced the proportion of fragmented treasury bonds, and improved the continuity of pricing in the primary market. In terms of the issuance mechanism, we have continuously improved the mechanism for bidding and issuing treasury bonds and implemented the pre-issuance mechanism to promote the price discovery of the primary market of treasury bonds and improve the timeliness and accuracy of the treasury bond market reflecting market supply and demand. In the secondary market, establish and improve the market making support mechanism for the secondary market of treasury bonds, and improve the liquidity of the secondary market of treasury bonds. In terms of opening up to the outside world, we have promoted the inclusion of Chinese treasury bonds in the international mainstream bond index, promoted the opening of the northbound bond link, and promoted the opening of the treasury bond market to investors in the world.
In terms of investor structure, looking back at the investor structure of the mainland treasury bond market since 2008, it can be seen that although the treasury bond holdings of commercial banks have been ranked first, the proportion of investors in other categories of the market has been increasing since 2014, especially the proportion of relatively active securities and funds holding treasury bonds has increased, and with the development of Bond Connect, the proportion of foreign institutional positions has continued to rise, which has promoted the improvement of liquidity in the treasury bond market.
Table: Structure of Treasury Bond Market Custody (Major Institutions)
Note: There are changes in the caliber of custody data disclosed by CCASS in 2020
In terms of market conditions, from the comparison between the treasury bond market turnover rate and the ten-year Treasury bond yield, in 2013-2014 and 2017, the Treasury bond turnover rate experienced two short periods of volatility and decline, corresponding to the stage of the bear market in the bond market; and in the stage of the bull market in the bond market, the treasury bond turnover rate generally showed an increase. This shows that the liquidity of the mainland treasury bond market is also affected by market conditions.
Figure 4: China's Treasury Bond Swap Rate vs. 10-Year Treasury Yield
Second, the important role and significance of improving the liquidity of the treasury bond market
(1) Improving the liquidity of the treasury bond market can better achieve resource allocation
The improvement of treasury bond liquidity makes the price reflect the market supply and demand relationship in a more timely manner, improves the market-oriented interest rate formation mechanism, gives play to the role of risk-free interest rate as the basis for the pricing of various types of assets, and helps interest rate transmission and market-oriented reform. At present, the yield curve of treasury bonds has been widely used in SDR interest rate basket, pricing benchmarks for local government bonds and long-term treasury bonds, bond valuation benchmarks for securities funds, reference benchmarks for insurance reserve measurement and bond investment measurement of commercial banks, pricing reference benchmarks for insurance asset management products and wealth management products, and daily market monitoring and risk management tools for collateral management such as cinchback treasury bonds offsetting futures margins.
The improvement of liquidity in the treasury bond market will help to better play the risk management and hedging functions of treasury bonds, and treasury bonds and various financial derivatives derived from the treasury bond market provide effective investment and risk management tools for the market. Since April 2020, commercial banks have participated in the treasury bond futures market, which is conducive to further enriching interest rate risk hedging tools and enhancing operational stability for treasury bond spot investors.
(2) The improvement of liquidity in the treasury bond market is conducive to macroeconomic regulation and control
The increase in liquidity in the treasury bond market can provide a market environment guarantee for the issuance of treasury bonds to make up for the deficit, meet the government's financing needs, and manage the cost of fiscal financing. The annual issuance of treasury bonds has increased from more than 800 billion yuan in 2008 to about 7 trillion yuan in 2020, and the balance of national bonds has increased from 5 trillion yuan to 20 trillion yuan, which has played an important role in completing the task of fiscal financing, implementing macroeconomic regulation and control policies, and promoting the rapid and healthy development of the economy and society. In the one and a half months from June 18 to July 30, 2020, 1 trillion yuan of special anti-epidemic treasury bonds were issued, which epitomized the important supporting role of the liquidity of the treasury bond market in implementing a proactive fiscal policy and reducing the impact of economic cycle fluctuations.
(3) Improving the liquidity of the treasury bond market is conducive to opening up to the outside world
With the rapid improvement of liquidity in China's treasury bond market, the amount of book-entry treasury bonds held by foreign institutions has increased from 0.6 trillion yuan at the end of 2017 to 2.1 trillion yuan in May 2021; in the context of the spread of the new crown epidemic, the increase in quantitative easing of central banks in Europe and the United States, and the continuous expansion of the scale of negative interest rate bonds in the world, China's government bond market provides attractive investment tools for overseas investment institutions. The opening up of the treasury bond market is conducive to further improving the institutional mechanism of the mainland market, increasing the proportion of Chinese treasury bonds in overseas reserve currency assets, promoting the internationalization of the renminbi, and supporting the construction of a new development pattern with the domestic cycle as the main body and the domestic and international dual cycles promoting each other.
Third, the high-liquidity treasury bond market will help improve the modern fiscal and taxation system
(1) The role and significance of the high-liquidity treasury bond market in improving the modern fiscal and taxation system
The 14th Five-Year Plan proposes to speed up the establishment of a modern fiscal and taxation system. Improving the management mechanism for the issuance of government bonds, optimizing the variety and maturity structure of treasury bonds, promoting the healthy development and opening up of the treasury bond market to the outside world, and giving better play to the role of the market pricing benchmark of treasury bond interest rates are the inherent requirements for accelerating the establishment of a modern fiscal and taxation system.
The construction of a highly liquid treasury bond market has a key position in the construction of the treasury bond market. For treasury bond issuance, the highly liquid treasury bond market can better meet the needs of fiscal financing, realize the primary market price discovery function, and help manage the cost of fiscal financing. For the optimization of the structure of varieties and terms, only when the liquidity reaches a certain level can it become a tool for all kinds of investors to participate in investment, reflecting the market information and supply and demand of all parties, thereby establishing market influence. For the opening up of the treasury bond market to the outside world, further improving the liquidity of the treasury bond market can further narrow the market liquidity gap between the mainland and major economies, and combine the continuous improvement of treasury bonds and related derivatives and market mechanisms to enhance the attractiveness of mainland treasury bonds among foreign investors. For the role of pricing benchmarks, high liquidity is the market characteristic of the benchmark interest rate, with reference to the Bank for International Settlements' characteristic standards for the benchmark interest rate, the interest rate benchmark is generated from the liquidity and active market transactions, is not easy to be manipulated by the market, and can provide a stable and accurate interest rate reference.
(2) Suggestions on further enhancing the liquidity of the treasury bond market
First, it is proposed to change the current situation of the segmentation of the treasury bond market and achieve unified interconnection. The secondary market of treasury bonds is divided by different market functions, systems and supervision, different types of treasury bonds cannot circulate freely between different markets, and there are still obstacles to cross-market investment of participating entities, which affects the liquidity of the market, the timeliness and accuracy of price discovery, and also leads to differences in the liquidity of different markets to a certain extent.
Second, it is recommended to further enrich and improve the bond varieties of the treasury bond market, and it is recommended to study and issue the Chinese version of inflation-preserving treasury bonds (TIPS), on the one hand, it can reduce the issuance cost by avoiding paying the inflation risk premium, on the other hand, providing anti-inflation investment varieties for the market can attract long-term capital investment such as pension funds and sovereign wealth funds, and can also realize the discovery function of expectations for the average inflation level in the future, which is of positive significance for improving the overall liquidity of the treasury bond market.
Third, it is recommended to promote the linkage development of the treasury bond derivatives market. It is recommended to enrich the maturity of treasury bond futures, launch 30-year treasury bond futures, provide investors with hedging tools for ultra-long-end treasury bonds, improve the liquidity of ultra-long-end treasury bonds, make the liquidity of key-term treasury bonds from short-end to ultra-long-end more balanced, and improve the effectiveness of the yield curve. It is recommended to further develop the bond lending market, broaden the types of participating institutions, encourage transactional investors to participate in bond lending transactions, improve the short-selling mechanism of the treasury bond market, and improve the price discovery function of the treasury bond market.
Fourth, it is recommended to further encourage diversified entities to participate in the treasury bond market. At present, banks still account for the largest proportion of investors in the treasury bond market, and the interest income of the holding period obtained by banks investing in treasury bonds can be exempted from VAT and income tax, but the capital gains obtained need to pay VAT and income tax, and the difference in taxes is one of the reasons why banks tend to hold treasury bonds, so it is recommended to unify the interest and capital gains tax arrangements for banks to invest in treasury bonds, so as to provide positive guidance for encouraging banks to conduct transactions. It is recommended to encourage trading investors to participate in the treasury bond market and promote the diversification of market makers in the bond market. (Author Affilications:Pengyang Fund Management Co., Ltd.)
This article originated from China Finance and Economic News Network